Federal Reserve Board Chairman Jerome Powell speaks during a news conference after a Federal Open Market Committee meeting on 14 December 2022. AFP
Federal Reserve Board Chairman Jerome Powell speaks during a news conference after a Federal Open Market Committee meeting on 14 December 2022. AFP.
The Federal Reserve’s December meeting minutes – when its fed funds rate was increased by 50bps to 4.25-4.50% after four 75bps hikes as the chart below illustrates – showed the Federal Open Market Committee remains hawkish.
Source: Bank of Singapore, Bloomberg.
Secondly, the minutes warned that no FOMC official anticipated cutting interest rates later in 2023 after the Fed had finished increasing rates this year.
‘No participants anticipated that it would be appropriate to begin reducing the federal funds rate target in 2023.’
The FOMC warning is significant as it contrasts sharply with investors’ expectations of the Fed reducing interest rates subsequently this year as inflation starts easing back towards its 2% target.
The minutes therefore keep us cautious near-term on risk assets. We expect the Fed will increase interest rates more than markets anticipate this year by another 50bps in February and a further 25bps in March. This will lift the fed funds rate to 5.00-5.25%. We also, like the Fed, do not expect inflation will fall enough in 2023 to enable interest rates to be cut later this year.
We thus see the hawkish Fed and recession risks capping long-term Treasury yields to the benefit of developed market, investment grade bonds. We think 10Y yields may still be volatile in the next few months. But we think increases above 4.00% will prove unsustainable and forecast 10Y yields to be anchored around 3.50% over 2023. The last chart shows US manufacturing is already in recession and we expect America’s GDP will suffer two quarters of declines in 2H23. This will cap long-term Treasury yields during this year.
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